In an order that has caught the market by surprise, Securities and Exchange Board of India (SEBI) has levied a penalty of Rs1 lakh each on DSP Investment Managers and DSP Trustee for bearing extra expense ratio of its DSP Nifty 50 ETF scheme on its own books. The DSP Nifty 50 ETF was launched in 2021 December and the total expense ratio was supposed to be 0.16%. However, the fund house charged just 0.07% from the scheme and soaked up the remaining 0.09% on its own books.
The charges levied by a mutual fund for managing a scheme are described as the Total Expense Ratio (TER). This is calculated as a percentage of the scheme’s net asset value (NAV). On a daily basis, the NAV of a scheme is updated and disclosed after deducting the TER. SEBI regulations currently cap the TER that can be charged on any scheme. This is done on the basis of the assets under management (AUM) in a scheme.
DSP Mutual Fund (MF) in its compliance test report for the March quarter and half-yearly trustee report ended March informed SEBI that the total expense as a percentage to average AUM was higher than the TER charged to the scheme (DSP Nifty 50 ETF); the excess expenses were borne by DSP Investment Managers. The reason for the AMC bearing the excess expenses is the competitive market. Increasing of TER would have restricted the ability to increase the scheme’s AUM, it said.
The market watchdog said that even though the amount of expense of scheme borne by the AMC was miniscule at Rs53,238, it cannot ignore the gravity of violations involved in the matter as total expense ratio of a scheme is one of the important parameters for investors while taking investment decisions. If a scheme discloses TER lower than in reality, the disclosed TER is misleading.
The AMC has violated SEBI circular which requires all scheme-related expenses to necessarily be paid from the scheme only within the regulatory limits and not from the books of the AMC, its associate, sponsor, trustee or any other entity through any route, it said.
"By absorbing the expenses, the intention of the DSP Investment Managers was to solely keep the expense ratio competitive to attract investors and scale up the assets under management (AUM), since the scheme’s expense was in actual 0.16% whilst it has disclosed TER of 0.07%," SEBI said in its order.
The regulator said the practice of paying the expenses of the scheme from AMC books can only be afforded by profitable AMCs or AMCs with deep pockets whereas small AMCs won’t be able to bear such expenses from their books.
"Disclosing incorrect TER of scheme which will create anomalies in the Mutual Fund industry and will lead to unhealthy competition in the mutual fund industry," Vijaykumar Varma, the adjudicating officer said in his order.
Sandeep Parekh, former ED, SEBI, who is a noted securities lawyer, said in a tweet, “This is a profoundly wrong order. Yes, the circular referred to is a little ambiguously worded—but the intention is very clear - that mal-practices with respect to payment of distributors from AMC’s pockets be dis-allowed.”
Mr Parekh explained that Regulation 52(5) allows the AMC or sponsor to pay for expenses beyond the 1% regulatory cap. Thus, a circular interpreting a prohibition on payment from AMC or sponsor must either be void, or must be read down (in the present case, it should be read down - because the language suggests that what was being prohibited was payment of commissions to distributors from AMC’s pockets).
Mr Parekh added that this is great for investors, who really are being subsidised by the AMC—and it is the market forces at play which keep the costs down for investors. Penalising it is a serious regulatory self-goal. This sends a very powerful message to the market—that SEBI is done with catching all the mischief and fraud in the market and now is ready to outlaw a trivial, competitive-market based, honest and investor-beneficial action.
Many others from the industry are echoing this view and hinted at over-regulation by the regulator. However, a few found SEBI’s action fair because artificial low TER (say, 0.1%) of Fund-A (low AUM) may mean artificial high TER (say, 0.6%) of Fund-B (high AUM), this is delusional for Fund-A & unfair to Fund-B investors. Once Fund-A gathers higher AUM, TER's of both funds will be adjusted.
It may be recalled that just last week SEBI initiated a study of the regulations pertaining to the fees and expenses in MF schemes. Sources say the regulator is likely to pay close attention to the cost of distribution of MF schemes.
